Tax bill has virtues, but the damper on capital gains isn't one

SERIOUS work remains to be done on the tax reform bill. Between now and the time the House and Senate conference committee begins reconciling the two versions of the bill, probably in mid-July, public discussion should set the stage for correcting the worst flaws in the Senate version. First of all, the general aim of both versions to simplify and to do away with tax breaks that tend to distort economic decisionmaking should be applauded. Thus, the heavy blow the Senate version gives to tax shelters is certainly on the right track.

But neither version of the bill is going to simplify the average person's tax return very much. Whether there are two tax brackets or three, it won't be any easier to figure your taxes than it is with 14 brackets.

All one has to do now is look in the tax tables on the appropriate line and make one calculation. Unless there were a flat tax, two brackets would require the same amount of calculation.

Since most deductions are still allowed, most families will have the same amount of record-keeping to do that they've always done. This is not to say that this is bad, only that one has to be rather gullible to believe that preparing his taxes will be much simpler.

The deduction for individual retirement accounts has to be resolved. The Senate has disallowed it for individuals covered by company pension plans. In the long run, with lower tax brackets the IRA deduction is probably not as important as it was. But doing away with something that has been in effect for only five years -- and which many look on as an alternative to social security when the system runs into actuarial problems again after the year 2000 -- has an element about it of breaking faith with the public. Public pressure may well restore the full deductibility for IRAs.

The item that seems almost outrageous to me is the Senate's doing away with capital-gains taxation by lumping in capital gains with income. They are not income, no matter what our elected officials may care to think.

The US tax code for decades has recognized the different nature of capital gains, and doing away with that differentiation will affect the liquidity of capital (increasing reluctance to realize a gain) and discourage genuine risk-taking. Both bills have elements that affect business negatively; there's no reason to discourage individual risk-taking.

There is an easy way to restore the capital-gains provision at a maximum rate of, say, 20 percent. That is to add a third, perhaps even a fourth, bracket for very high earned incomes. The computer models Congress uses can estimate with sufficient accuracy how high the brackets on marginal income need to go to compensate for the lower capital-gains rate.

There is actually another reason for this compromise. While lower tax rates in general are desirable, there are few who think it wrong to tax high incomes at somewhat higher rates. Much of the salary structure of large companies is determined by the number of layers of management and the need to differentiate each layer by a significantly higher salary level.

Taxing salaries of, say, $200,000 and more at materially higher marginal rates would raise only a limited amount of additional revenues, but it would add to the public's perception of fairness in the tax code. This assumes that capital gains would be restored, so that individuals actually putting their capital at risk would be treated fairly for that risk.

Everyone who thinks about tax reform has his own list, of course. The political process must of necessity make compromises among a vast number of interests.

There are many good elements in both versions of the bill. Restoring the differentiation for capital gains, adding a bracket or two for very high incomes, and possibly restoring full deductibility for the IRA would, at least in my opinion, vastly improve the bill and make it more likely that the public would feel it has a tax law that can stay on the books for a long time.